Following Rules On IPOs Helps Avoid Buying Duds

The launch of an initial public offering creates excitement but also risks.

An IPO lacks several key tools investors use to evaluate a stock.

On its debut, the stock lacks a 50-day and 200-day moving average. Daily volume also is hard to read. An early surge can obscure where the average will settle. An Accumulation-Distribution Rating is missing. Reports of fund activity also will take time to appear.

When Facebook debuted in 2012, revenue growth had declined for five consecutive quarters — from 276% to 112%, 108%, 104%, 55% and 45%. The earnings growth trend was just as bad, if not worse: from 300% to 175%, 100%, 100%, 25% and 9%.

Still, a Sterne Agee analyst initiated coverage with a buy rating even before the IPO was priced.

Morningstar was wary. It noted a lack of clarity on return on investment for Facebook advertisers. Morningstar added that founder Mark Zuckerberg has voting control: The board of directors can put few checks on him.

IBD warned five days before Facebook's IPO that, "Stripping away the emotion and hype, the financial performance of Facebook is disconcerting."

The stock debuted with an ugly negative reversal1. By early September, the stock traded as much as 61% off its opening-day high2. The stock has recovered mildly but is still 45% below its post-IPO peak of 45.

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